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Episodes of market crashes have fascinated economists for centuries. Although many academics, practitioners and policy makers have studied questions related to collapsing asset price bubbles, there is little consensus yet about their causes and effects. This review and essay evaluates some of the hypotheses offered to explain the market crashes that often follow asset price bubbles. Starting fromhistorical accounts and syntheses of past bubbles and crashes, we put the problem in perspective with respect to the development of the efficient market hypothesis. We then present the models based on heterogeneous agents and the limits to arbitrage that prevent rational agents from bursting bubbles before they inflate. Then, we exploreanother set of explanations of why rational traders would be led to actually profit from and surf on bubbles, by anticipating the behavior of noise traders or by realizingthe difficulties in synchronizing their actions. We then end by discussing a complex system approach of social imitation leading to collective market regimes like herdingand the phenomenon of bifurcation or phase transition that rationalize what crash can occur in unstable market regimes. The key insight is that diagnosing bubbles maybe feasible when taking into account the positive feedback mechanisms that give rise to transient -super-xponential- price growth, the bubbles.

Item Type: MPRA Paper -

Original Title: Market Bubbles and Crashes-

Language: English-

Keywords: Financial bubbles, crashes, efficient market hypothesis, positive feedback, noise traders, super-exponential, heterogeneous beliefs, synchronization failure, social imitation, complex system theory, collective phenomena, bifurcation, phase transition-

Subjects: G - Financial Economics > G1 - General Financial Markets > G14 - Information and Market Efficiency ; Event Studies ; Insider TradingG - Financial Economics > G1 - General Financial Markets > G12 - Asset Pricing ; Trading Volume ; Bond Interest RatesG - Financial Economics > G1 - General Financial Markets > G11 - Portfolio Choice ; Investment DecisionsG - Financial Economics > G0 - General > G01 - Financial Crises-

Autor: Kaizoji, Taisei


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